8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
1/88
New IFRS for Acquisitions (M&A)
What impacts on your financial statements and communication?
How should your acquisition strategies and terms be adapted?
A Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
2/88
April 2008
For contact details
on New IFRS for Acquisitions (M&A)
see insert
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
3/88
New IFRS for Acquisitions (M&A)
Acquisitions and disposals represent a core growthstrategy for companies.
In January 2008, the IASB (International Accounting
Standards Board) released a new version of IFRS 3,
which will have substantial and frequently counter-
intuitive consequences on financial statements.
Even if the new standard will mandatory apply to
t ra ns a c t i o ns d a t i ng fro m 2010, i t c o ul d wi d e l y
influence acquisition strategies from now.
This Pocket Guide is very pratically oriented for deal-
makers and preparers.
It provides practical advice for optimising decision-makingwith regard to:
acquisition and disposalstrategies;
due diligence work and contractualclauses;
the use of expertvaluations; and
the presentation of financial performance and
financial communication.
It also contents an exclusive interview with Philippe
Danjou, member of the IASB, who explains and
defends the advantages afforded by the new standard.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
4/88
SUMMARY
Executive summary 3
Why is it important to look
at the new IFRS standard now? 11
Impacts on financial statements
and financial communication
Disconnectionbetween cash & earnings/equity 20
Fair value measurement and volatility 28
Full or partial goodwill method 36
Strategic and operational impacts
Adaptationof acquisition strategies 44
Adaptation of contractual clauses 51
Use of expert valuations 59
Interview with Philippe Danjou
of the IASB 67
Detailed table of contents(including the 33 questions) 77
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
5/88
"Pocket Guide"Pocket Guidel3 l
EXECUTIVE SUMMARY
Why is it important to lookat the new IFRS standard now?
Acquisitions and disposals represent a core growth
strategy for many companies. In January 2008, the
IASB (International Accounting Standards Board)
re l e a s e d a ne w, g ro und -b re a ki ng s t a nd a rd o n
business combinations. The standard: highlights the importance of the existence or
absence of control over another company, and
exacerbates the disconnection between cash flow
and accounting earnings;
results in more fair value measurement particularly
in the post acquisition period, this is likely to add to
earnings volatility.The resulting impact on financial statements of the
new standard may be substantial and may also be
counter-intuitive. For example gains arising on step
a c q ui s i t i o ns wi l l b e re c o g ni s e d i n t he i nc o m e
statement and transaction costs will be expensed as
incurred (and no longer included in goodwill), etc.
Buyers and sellers alike would be well advised to anticipate
the accounting consequences on deals, by possibly:
adapting their acquisition strategies,
amending contractual clauses, and
increasing their valuation capabilities.
The new standard will apply only to transactions dating
from 2010, but could be applied on an anticipatorybasis to transactions conducted in 2009 as soon as it
is endorsed. Although deals completed prior to
adoption will not be restated, acquisition and disposal
strategies are likely to be affected straight away.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
6/88l4 l New IFRS for Acquisitions (M&A)
EXECUTIVE SUMMARY
Disconnection
between cash & earnings-equity
IFRS 3R - a disconnection between cashand earnings-equity?
Consolidated financial statements under the new
version of IFRS 3 are now prepared as those of a
single economic entity with majority and minority
owners rather than from the perspective of the parent
companys shareholders. All transactions between anentitys owners are reflected solely in equity. Only step
acquisitions or disposals that involve change in control
trigger the recognition of gains or losses in the income
statement.
A consequence of the economic entity approach is
that it produces an apparent disconnect between cash
flow and earnings or equity movements. A challengefor management will be to explain the impact of
transactions accounted for under the new standard.
Some examples of the impact of the new standard:
the purchase of non-controlling interests will reduce
equity and can appear to be value destruction;
the sale of 30% of a 100% owned subsidiary with afair value substantially higher than book value with
no disposal gain; and
control of a company is obtained by acquiring 13%
on top of the 38% already owned, the 38% that the
entity still owns gives rise to a substantial (yet
unrealised) gain in the income statement.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
7/88
"Pocket Guide"Pocket Guidel5 l
EXECUTIVE SUMMARY
Fair value measurement and volatility
IFRS 3R - more fair value and more volatility
in earnings and equityFair value is already the standard valuation basis for
the measurement of identifiable assets and liabilities
when preparing the acquisition date balance sheet.
However, the new IFRS 3 goes further by prescribing
wider use of fair value and by fixing the amount of
goodwill at the date at which control is obtained.
Illustrations of this point: earn-out clauses (contingent consideration) are
included in the measurement of consideration at the
acquisition date and thus the initial measurement of
goodwill;
g o o d w i l l o n n o n - c o n t r o l l i n g i n t e r e s t s i s n o t
subsequently adjusted, even in a buyout context;
and
the fair value measurement of identifiable assets and
liabilities has been expanded to include more
intangible assets, as well as re-assessment and
potential reclassification of some financial instruments.
The 12-month period for finalising the business
combination accounting has, however, been retained.Accordingly, any subsequent changes in fair value are
recognised in the income statement (or in equity, in the
case of the buyout of non-controlling interests), rather
than some adjusting goodwill as today.
This may well result in greater volatility for several
years following the acquisition, in addition to theincome statement impact expected in the year of
acquisition arising from expensing transaction costs
and recognition of gains related to previously held
interests (step acquisitions).
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
8/88
Full or partial goodwill method
Considerations on choosing
between partial and full goodwill under IFRS 3RToday, in a less than 100% acquisition, a buyer reco-
gnises 100% of the identifiable assets and liabilities
acquired and goodwill calculated as a residual compa-
ring the consideration paid to the acquirers interest in
identifiable assets and liabilities. IFRS 3R introduces
an option for the buyer to value the non-controlling
(minority) interest at either the minoritys proportionate
share of the net identifiable assets (residual method as
today or partial goodwill) or to value the non-control-
ling interest at fair value, thus recognising goodwill on
the non-controlling share (full goodwill).
What would influence an acquirer to choose between the
partial goodwill method and the full goodwill method?The recognition of full goodwill increases equity at the
acquisition date. It would also reduce any potential
decrease in controlling (parent) equity resulting from a
subsequent buyout of the non-controlling interest. Full
goodwill might be best suited to companies with a
weak equity base and/or a high level of gearing.
However, the full goodwill method also has a number
of drawbacks:
The fair value measurement of the non-controlling
interest may require the use of complex valuation
techniques;
Any subsequent impairment charge is higher than
under the partial goodwill method, with a negativeimpact on reported operating results.
Buyers are allowed to decide which method is more
appropriate on a transaction-by-transaction basis an
area of flexibility allowed by the new standard.
EXECUTIVE SUMMARY
l6 l New IFRS for Acquisitions (M&A)
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
9/88
"Pocket Guide"Pocket Guide
Adaptation of acquisition strategies
Why should decision-makers anticipate
the new version of IFRS 3 and adapt acquisitionand disposal strategies and terms accordingly?
Acquisition and disposal decisions should not be
driven by accounting considerations. Moreover, the
exact time frame for deal-making and negotiations is
seldom known in advance. However, decision makers
like to be able to develop their own strategy, be that:
purchasing an equity stake in the target company
prior to pursuing control, in order to test the water;
purchasing a minimum controlling interest at first
and buying out NCIs (NCI, previously minority
interest) at a later date;
acquiring 100% control from the outset, increasing
t he v a l ue o f t he a c q ui re d b us i ne s s a nd t he ndisposing of shares without, however, giving up
control; or
acquiring control, increasing the value of the
acquired business, then disposing of shares and
retaining only a NCI.
The terms of transactions under IFRS 3R could havevery different and potentially counter-intuitive effects
on earnings and equity. Management should consider
if the previous strategy for business acquisitions is the
right one under the new accounting requirements.
The best way to avoid surprises is to anticipate the
consequences of the proposed transaction terms and
t h e n e w a c c o u n t i n g s t a n d a r d o n t h e f i n a n c i a l
statements at an early stage and to model potential
outcomes.
EXECUTIVE SUMMARY
l7 l
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
10/88l8 l New IFRS for Acquisitions (M&A)
EXECUTIVE SUMMARY
Adaptation of contractual clauses
IFRS 3R - how might it change contracts for business
combinations?Managers are already taking a close look at the
contractual clauses associated with acquisitions,
particularly with regard to the cash component of
earn-outs, post-acquisition payments to selling
shareholders and indemnity clauses. Depending on
the terms of the arrangement, fair value adjustments
related to these items might need to be recognised inthe income statement, rather against goodwill as
today. Good planning and hard negotiating may
reduce or eliminate earnings volatility in the wake of an
acquisition. There are some significant areas that merit
consideration to meet this challenge:
expand the scope and extent of due diligence work
and either replace earn-out arrangements by a
d ef in it iv e a cq ui si ti on p ri ce ( l oc ke d b ox
mechanism) or shorten the duration of earn-outs;
pa y e ar n- ou ts i n a f ix ed n um be r o f e qu it y
instruments;
use valuation experts and benchmarking techniques
to assess the fair value of earn-out clauses asaccurately as possible.
However, to reduce or eliminate earnings volatility,
companies should:
negotiate for robust liability indemnification clauses
and better monitor related compliance; and
carefully word clauses governing payments due to
former owners retained in the business after theacquisition date.
These changes should be made before contracts are
signed to avoid problems further down the road.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
11/88
"Pocket Guide"Pocket Guidel9 l
EXECUTIVE SUMMARY
Use of expert valuations
How does IFRS 3R increase the use of valuations
in acquisitions and disposals?Accurate fair value measurements of acquired assets
and liabilities in a business combination can present
real challenges to companies today. The wider use of
fair value under IFRS 3R may increase both the
number and complexity of valuations.
There is an incentive for assessments to be even moreprecise and reliable, given that re-measurements after
the acquisition date will be recognised in the income
statement.
The main consequences on the valuation front are
likely to relate to:
estimates of earn-outs, including the modelling oft he p ro b ab i li t y o f p re -de fine d p e rfo rma nce
objectives being achieved;
the analysis and quantification of control premiums,
with a view to measuring non-controlling interests;
the measurement of unusual intangible assets or
i n de mn it ie s c on ce r ni n g l i ab il i ti es , s uc h a s
environmental risks; and
the reassessment of financial assets and liabilities,
notably hedging instruments and embedded
derivatives.
The challenges ahead may see companies seeking
additional input from experts armed with a strong
knowledge of valuation techniques and of the sectorsin which their clients operate.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
12/88
Interview with Philippe Danjou
What improvements does the new IFRS 3 bring
to international accounting regulatory governance,to competition between companies
and to transaction management ?
Acquisitions and disposals are of strategic importance
to companies. This importance was brought to the
fore in January 2008 with the new IFRS 3. The new
version of the standard represents a significant
improvement from previous guidance and will produce
new effects on financial statements as from 2009
onwards. With this in mind, we urged companies in
our previous contributions to consider the implications
of the new standard now (see Q1 to Q3).
Our presentation of the difficulties associated with
applying the standard and the counter-intuitiveconsequences relative to current practice has struck a
chord with readers. This is especially pertinent since
the adoption of the standard by the European Union in
the coming months is a crucial step for the IASB.
Philippe Danjou, member of the IASB, here explains
and defends the advantages afforded by the newguidance in his responses to the following questions.
How does the new IFRS 3:
i m prov e i nt erna t io nal a c co unt i ng reg ul at o ry
governance?
level the playing field for European and American
companies?
enhance transaction transparency? live up to the simplification of guidance announced
by the IASB?
facilitate the management of acquisitions?
EXECUTIVE SUMMARY
l10 l New IFRS for Acquisitions (M&A)
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
13/88
"Pocket Guide"Pocket Guidel11 l
WHY IS IT IMPORTANT TO LOOK
AT THE NEW IFRS STANDARD NOW?
Why is it important to look
at the new IFRS standard now? 12
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
14/88
Why is it important to look at the new IFRS
standard now?
Acquisitions and disposals represent a core growthstrategy for many companies. Accounting conside-
rations should not drive transaction decisions but
accounting can have a real impact on deal structure
and planning, contractual clauses and communica-
tions with the marketplace.
In January 2008, the IASB (International AccountingSt a nd a rd s Bo a rd ) re l e a s e d a ne w s t a nd a rd o n
business combinations, accompanied by a revised
standard on consolidated financial statements that
requires the use of the economic entity model.
A number of significant changes are looming. In
particular, the new standard:
reinforces the importance of the existence or
absence of con trol over a compan y, and
exacerbates the disconnection between cash flow
and accounting earnings;
prescribes the wider use of fair value measurement
particularly in the post acquisition period, which is
likely to add to earnings and equity volatility.
The resulting impact on financial statements may be
substantial and counter-intuitive. This means that
buyers would be well advised to anticipate the
accounting consequences on deals, by possibly:
adapting their acquisition strategies,
amending contractual clauses, and
increasing their valuation capabilities as these skills
may be needed more frequently and for more
complex issues.
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
l12 l New IFRS for Acquisitions (M&A)
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
15/88
"Pocket Guide"Pocket Guidel13 l
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
The new standard gives pride of place to two major
concepts: control and fair value
Control as a key determinant
The majority of companies have been preparing their
consolidated financial statements from the perspective
of the parent company exercising control over anotherentity. The new standard requires the adoption of the
economic entity model. Under this approach,
consolidated financial statements are treated as those
of a single entity and are prepared from the perspective
of both categories of shareholder majority and
minority. Only a handful of IFRS companies are using
economic entity today.Two noteworthy consequences of this new approach
are as follows:
The assumption or loss of control changes the
economic entity. Therefore, a change in control
conditions the recognition of a gain (or potentially a
loss) in the income statement; and Where acquisitions or disposals of equity interests
do not result in a change in control, the economic
entity is perceived as intact. Such transactions are
t r e a t e d a s h a v i n g n o i m p a c t o n t h e i n c o m e
statement and are reflected only in equity.
These effects may seem counter-intuit ive. The
economic entity approach may also be seen by some
to exacerbate the disconnection between the cash
paid for acquisitions (or received for disposals) and
fluctuations in earnings or equity. Specifically, the
Q1. In what way is the new standard on
acquisitions and disposals ground-breaking?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
16/88l14 l New IFRS for Acquisitions (M&A)
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
prescribed accounting treatment could lead to
depicting a step acquisition as wealth-enhancing and
the acquisition of a non-controlling interest as wealth-
destroying. This may well be hard to explain toanalysts and users.
Ever-wider application of fair value measurement,
leading to increased earnings volatility
Fair value measurement is increasingly present
throughout the process of acquiring control and the
related consequences wil l be felt in the year ofacquisition and beyond. For example:
In the context of a step acquisition, any previously-
held equity interest in the acquiree is required to be
re-measured to fair value and the resulting gain or
loss is recognised in the income statement in the
year of acquisition. This was previously recorded in
equity;
Transaction costs will no longer be included in the
acquisition price and are expensed as incurred;
Any earn-out must be recognised at fair value at the
date of the transaction (regardless of probability)
and any subsequent re-measurements (after the
measurement period) are recognised in the incomestatement (and no longer in goodwill);
The requirement to recognise all of the identifiable
assets and liabilities of the acquiree at fair value will
cover a larger number of intangible assets, given
that the reliable measurement criterion is now
deemed to be met for all intangible assets;
The new standard requires that deferred tax assets
be treated in the same manner as other assets;
adjustments relative to the business combination
accounting on day 1 must be recorded in the
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
17/88
"Pocket Guide"Pocket Guidel15 l
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
i nc ome st at eme nt a s pa rt o f t ax e xp en se i n
subsequent years; and
There is no requirement to measure non-controlling
(minority) interests at fair value (including related
g o o d wi l l ) . Ho we v e r, und e r t he o p t i o na l ful l
goodwill method, non-controlling interests may be
m e a s ure d a t fa i r v a l ue o n a t ra ns a c t i o n-b y -
transaction basis (see Q18).
Major implications to take into account in the early
stages of acquisition and disposal strategies
The new standard has some significant implications.
The accounting consequences might be counter-
intuitive and potentially unmanageable for an acquirer
that doesnt pay attention to the new requirements.
Buyers and sellers alike should look now at acquisition
structures and plans with a view to el iminating
transaction terms that result in volatility. Management
should also consider the impact of transactions on
earnings and equity.
Actions could include:
changing acquisition and disposal strategies. For
example, where possible, buyers should weigh the
benefits and drawbacks of acquiring control of acompany in one or several stages and whether it is
necessary to buy 100% of the shares;
the enlargement of the scope and extent of due
diligence prior to and at the acquisition date;
t h e a me nd me n t ( or re pl ac em en t) o f c er t ai n
contractual clauses, notably those around earn-outs
or other contingent payments; and increase access to valuation expertise. Complex
models may be required and more valuations may
be needed for an entity active in acquiring and
disposing of businesses.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
18/88l16 l New IFRS for Acquisitions (M&A)
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
The standard is required for financial years
beginning on or after 1 July 2009
For example, a company with a 31 December financial
year-end will have to apply the new standard to
acquisitions and disposals occurring from 1 January
2010. However, the compulsory compliance date for a
company with a 31 October financial year-end, forexample, will be 1 November 2009.
However, the standard may be applied earlier
for transactions occurring as soon as 2009
European companies may indeed opt for earlier
adoption once the standard has been endorsed by the
European Union, i .e. probably for transactionsconducted as soon as 2009.
Co m p l i a nc e fro m 2009 wi l l b e c o m p ul s o ry fo r
American companies. There has been muted reaction
to the new standard in USA, despite the relatively
greater impact for them. Acceptance of the standard
on the other side of the Atlantic may overshadow thecriticism aroused by the new standard elsewhere and
persuade the European Union to endorse it (see QI
and QII, interview with Ph. Danjou).
Q2. Why look ahead now to the new standard?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
19/88
"Pocket Guide"Pocket Guidel17 l
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
Probable impact on transactions in 2008 and 2009,
ahead of the application of the standard
The new standard may not be applied retrospectively
to earlier or current acquisitions and disposals.
However, it is likely to have a strong influence on
forthcoming transactions, such as:
if a company has full control over the timing of a
transaction, it may want to advance or postpone the
deal depending on whether the current or new
version of the standard is more favourable; likewise, if a company does not have full control
over the timing of a transaction, it may consider the
b e n e f i t s v e r s u s t h e d r a w b a c k s o f t h e e a r l y
application of the new standard.
Th is a na ly si s c an b e a ppl ied t o a ll t yp es o f
transactions (acquisition of an interest, acquisition of a
controlling interest, step acquisitions, purchase of a
minority or a disposal).
Thus, there is much food for thought and reason to
reflect upon the accounting consequences of the new
standard as of now.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
20/88l18 l New IFRS for Acquisitions (M&A)
IMPORTANCE OF LOOKING AT THE NEW STANDARDS NOW
C om mo n co nt ro l t ra ns ac ti on s a re bu si nes s
combinations in which the same party controls the
combining entities. Transactions involving entities and
activities under common control remain outside the
scope of the new standard. The IASB is currently
working on this issue, but a new standard is not
expected soon. In the absence of explicit guidance,
companies may elect to apply fair value measurementby reference to the current standard or the historical
book values of the acquired assets and liabilities,
without recognising goodwill.
In conclusion, given the implications of the new
standard and its major accounting consequences,
potential buyers should focus on preparing for theapplication of the standard (see Q20 to Q24).
Q3. A new standard on common control?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
21/88
IMPACTS ON FINANCIAL STATEMENTS
AND FINANCIAL COMMUNICATION
Disconnection
between cash & earnings/equity 20
Fair value measurementand volatility 28
Full or partial goodwill method 36
"Pocket Guide"Pocket Guidel19 l
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
22/88
Disconnection between cash
& earnings-equity
IFRS 3R - a disconnectionbetween cash and earnings-equity?
Today, consolidated financial statements under IFRS
are prepared (almost exclusively) using the parent
company approach, i.e. they present the financial
situation of the parent companys shareholders only.
The revised standard on consolidation (IAS 27R)requires that consolidated financial statements instead
be treated as those of a single economic entity and
be prepared from the perspective of both categories of
owner majority and minority or controlling and non-
controlling interests using the new terminology.
Transactions between the controll ing and non-
c on tro ll in g s ha re ho ld er s d o n ot c ha ng e t he
c o m p o s i t i o n o f t he e c o no m i c e nt i t y . T he y a re
transactions between the companys owners and,
therefore, are reported only in equity. The replacement
of the parent companys perspective by the entitys
global perspective represents a ground-breaking
change. The related accounting consequences will besignificant, but also may be counter-intuitive for those
accustomed to the parent company approach.
The new approach creates or increases an apparent
d is co n ne ct i on b et we en c as h m ov em en ts a nd
fluctuations in earnings or equity. A buyout of non-
controlling interests has a negative impact on equity
and the disposal of a non-controlling interest in acompany whose shares have appreciated in value
does not, any longer, trigger the recognition of a gain
in the income statement.
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
23/88
"Pocket Guide"Pocket Guide"Pocket Guide"Pocket Guidel21 l
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
This disconnection will be apparent in the year of the
acquisition or disposal and will affect earnings and
equity in an unexpected manner.
Companies will need to:
anticipate the accounting consequences at a very
early stage of the acquisition strategy process and
a da pt t he ir s tr at eg ie s a cc ord in gl y, w he re
appropriate;
e xplain to the mar ketplace th e impact of
transactions on financial health and performanceratios, and the cash consequences of acquisitions
and disposals.
The current standard, IFRS 3, requires a buyer to
recognise an intangible asset once the item in
question meets the definition of such an asset and its
fair value can be measured reliably. This provision has
resulted in the recognition of many more intangible
assets. Many of these are internally generated by the
acquiree and include trademarks, customer lists, order
backlogs and, in some circumstances, research and
development projects. Recognition is mandatory even
if the items are not shown in the acquirees pre-
transaction balance sheet. The buyers income
statement is impacted by hefty amortisation charges
related to such acquired intangible assets during theyears following the acquisition.
Q4. How does the disconnection between cash
and earnings already exist in the current
standard?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
24/88l22 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
The two companies combined cash flow remains the
s a m e b e f o r e a n d a f t e r t h e a c q u i s i t i o n b u t t h e
consolidated income statement wil l include the
additional amortisation charges.
The resulting apparent decline in profitability measures
like EBITDA and P/E is often stripped out by many
analysts looking a company results. A business
combination is intended to generate synergies and the
prospect of a deterioration of performance ratios is
inhibitive and has even scuttled some deals !IFRS 3R may make some transactions even more
difficult to explain, as discussed below.
The new IFRS 3 will result in an increase in the number
of intangible assets carried on the balance sheet for
a cq ui si ti on p ur po se s. T hi s w il l i nc re as e t he
d is co n ne ct i on b et we en c as h m ov em en ts a nd
fluctuations in earnings or equity (see Q32). The gains
and losses arising from step acquisitions and partial
disposals are one element of this, the absence ofg a i ns a nd g o o d wi l l f ro m t ra ns a c t i o n wi t h no n-
controlling interests is another.
Q5. How does the new IFRS 3 exacerbate
the existing, intangible asset-related
disconnection between cash and earnings?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
25/88
"Pocket Guide"Pocket Guidel23 l
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
Recognition of a gain on the previously-held
equity interest, although there is no cash inflow,
but rather a cash outflow to pay for the additional
stake leading to the assumption of control
When a buyer achieves control through successive
share purchases (thereby increasing its interest from,say, 30% to 60%), the previously-held equity interest
in the acquiree must be re-measured to fair value and
the resulting gain recognised in the income statement
(rather than in equity as today). This treatment is
applicable irrespective of whether the previously-
owned shares were accounted for under the equity
method or as available-for-sale (AFS) financial assets.
The trigger for the recognition of the gain in a step
a c q ui s i t i o n i s t he c ha ng e i n c o nt ro l wi t hi n t he
e c o no m i c e nt i t y . T he b uy e r, p re v i o us l y o nl y a
shareholder in a company, now controls the individual
assets and liabilities of the target company. The new
standard treats a step acquisition as two transactions: the disposal of the previously-held equity interest
(30%), leading to the recording of proceeds or
gain in the income statement; and
the subsequent acquisition of control (60% interest
in our example) over the target company.
There is, obviously, no cash inflow for the buyer, butrather an outflow of cash to pay for the additional
shares.
Q6. How does obtaining control through
a step acquisition exacerbate the
disconnection between cash and earnings?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
26/88l24 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
Recognition of a gain on the interest retained
and on the shares disposed of,
although cash is received solely for the shares sold
Consider the case of a company which owns a 51%
controlling interest in a subsidiary and decides to sell
5% of the shares owned. Under IFRS 3R, a gain arisesnot only on the shares sold, but also on the 46%
interest retained. The 46% interest is re-measured to
fair value and any resulting gain or loss is recognised
in the income statement (together with the gain or loss
on the shares sold).
How may one explain the recognition of a gain on the46% interest retained when cash is received only for
the 5% of shares sold?
The trigger for the recognition of the gain under the
new standard is the loss of control (i.e. the reduction in
the sellers previous controlling interest to an equity
s t a ke ) , t ha t c ha ng e s t he e c o no m i c e nt i t y . T he
treatment of the partial disposal of shares with loss ofcontrol reflects two transactions:
the disposal and de-recognition of the individual
assets and liabilities of the subsidiary, leading to the
recognition of a gain on the shares retained and the
shares sold; and
the subsequent acquisition of shares correspondingto the retained stake.
In practice, cash is received only for the 5% stake
effectively sold.
Q7. How does a partial disposal
with loss of control exacerbate
the disconnection between cash and earnings?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
27/88
"Pocket Guide"Pocket Guidel25 l
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
Recognition of a disposal gain or loss in equity
and not in the income statement,
despite the existence of a cash inflow
Where a company has 100% control over a subsidiary
and decides to sell 30% of the shares, after having
increased their value, IFRS 3R requires that thedisposal gain be credited to equity. The controlling
interest (seller) has created value and will receive a
cash inflow, but no disposal gain will be recognised in
the income statement. Under the new standard, a
disposal of shares is treated as a transaction between
a single economic entitys two categories of owners.
Accordingly, the impact of the transaction must bereflected in equity and not in the income statement as
today. In other words, the treatment is the same as
that applied to treasury shares.
Q8. How does a partial disposal
without loss of control exacerbate
the disconnection between cash and equity?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
28/88l26 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
Reduction in equity despite the contribution
to its increase in value paid in cash
Under current practice, if a company acquires the
49% non-controlling interest of an entity already 51%
controlled by it, it records the difference between theacquisition price and the book value of the non-
controlling interest as additional goodwill. The buyout
of non-controlling interests under IFRS 3R is treated
as a transaction between a single economic entitys
two categories of owners. The marketplace may see
that the acquisition of non-controlling interests in a
profitable company results in a reduction in equity andvalue destruction.
Would it have been more advantageous for the buyer
t o a c q u i r e 1 0 0 % o f t h e s h a r e s i n o n e s t r o k e ?
Regardless of the option selected for the treatment of
goodwill (partial goodwill or full goodwill method),
the buyout of non-controlling interests will reduceequity if the fair value of the acquiree has increased
since the assumption of control (see Q16 Q19).
Q9. How does the buyout of non-controlling
interests after the assumption of control
exacerbate the disconnectionbetween cash and equity?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
29/88
"Pocket Guide"Pocket Guidel27 l
The disconnection between cash movements and
fluctuations in earnings or equity is bound to have
significant consequences, both during the year of
acquisition and beyond. Companies will need to
anticipate lack of understanding on the part ofinvestors and be ready to explain to financial analysts
a n d t h e i n v e s t m e n t c o m m u n i t y t h e i m p a c t o f
acquisitions and disposals on:
t he b uye rs v a ri o us p e rfo rma nce i ndi c at o rs,
i nc l ud i ng E PS, P/E a nd , whe re a p p ro p ri a t e ,
operating result and EBITDA ratios;
the buyers financial health ratios, notably the debt-to-equity ratio and, where appropriate, financial
covenants compliance.
Companies may want to realign their performance
ratios with the new standards.
They wil l also have to explain the real value of
acquisitions or disposals and the associated businessbenefits over a short- to long-term horizon.
For help with strategy and communication policy,
companies may refer to the explanations provided
above and to those hereinafter (see Q20 to Q24).
Q10. Given the counter-intuitive consequences
on financial ratios, how may companies
best rise to the increasing challengeof communicating with the marketplace?
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Disconnection between cash and earnings/equity
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
30/88
Fair value measurement and volatility
IFRS 3R - more fair value and more volatility
in earnings and equity
Fair value is already the standard valuation basis for
the measurement of identifiable assets and liabilities
when preparing the acquisition date balance sheet.
However, the new IFRS 3 goes further by prescribing
wider use of fair value and by fixing the amount of
goodwill at the date at which control is obtained.Illustrations of this point:
earn-out clauses (contingent consideration) are
included in the measurement of consideration at the
acquisition date and thus the initial measurement of
goodwill;
g oo dw i ll o n n on -c on tr ol l in g i nt er es ts i s n ot
subsequently adjusted, even in a buyout context;and
the fair value measurement of identifiable assets
and liabilities has been expanded to include more
intangible assets, as well as re-assessment and
p ot en t ia l r ec la ss if i ca ti on o f s om e f in an ci al
instruments.The 12-month period for finalising the business
combination accounting has, however, been retained.
Accordingly, any subsequent changes in fair value are
recognised in the income statement (or in equity, in the
case of the buyout of non-controlling interests), rather
than some adjusting goodwill as today.
This may well result in greater volatility for several
years following the acquisition, in addition to the
income statement impact expected in the year of
acquisition arising from expensing transaction costs
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
l28 l Acquisitions, Cessions et Joint-ventures
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
31/88
"Pocket Guide"Pocket Guidel29 l
and recognition of gains related to previously held
interests (step acquisitions).
All newly acquired or previously held interests in an
acquired business are measured at fair value at the
date control is obtained. The resulting value of
consideration and, therefore, the related goodwill isno t a d j us t e d s ub s e q ue nt l y . Any i m m e d i a t e o r
subsequent change in value of assets, liabilities,
contingent liabilities or contingent consideration is
recognised in the income statement, rather than in
goodwill or equity for some transactions as allowed
under IFRS 3 today.
The consideration given to obtain control
of the acquiree must be measured at fair value
This calculation excludes transaction costs such as
fees paid to intermediaries, consultants, lawyers, and
valuation experts. These costs are not part of the
acquirees intrinsic value and are expensed as incurred
under IFRS 3R.
The current standard treats transaction costs as a
component of the acquisition price and therefore they
fall into goodwill.
Earn-out clauses are measured at fair value
at the date at which control is obtained
The value of earn-out clauses and other forms of
contingent consideration is usually driven by the post-
acquisition performance of the acquired business.
Q11. Under the new standard, what is entailedby the measurement of shares at fair value
at the date of obtaining control?
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
32/88l30 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
Earn-outs are routinely based on, for example, growth
in turnover, operating result or the share price.
Earn-out clauses under IFRS 3R are measured at fair
value at the date at which control is obtained. The
probability of payment does not impact recognition but
will affect the valuation of the contingent consideration.
Any subsequent re-measurement is recognised in the
income statement. Earn-out clauses under the current
standard are recognised only if payment is probable
and reliably measurable. However, even when these arerecorded at the acquisition date any subsequent
adjustment is recorded against goodwill and not in the
income statement.
P re vio u sl y o wne d i n te re s ts i n t h e a c qu i re d
business must be re-measured to fair value (for
example, the acquisition of a 40% interest on top of
an existing 15% or 25% stake). The re-measurementof the existing 15% or 25% stake is performed at the
date at which control is obtained and any gain is
recognised in the income statement, rather than in
equity as today.
I F R S 3 R p r o v i d e s t h e o p t i o n t o m e a s u r e n o n -
controlling interests at fair value at the acquisition date
( f u l l g o o d w i l l m e t h o d ) o r t o r e c o r d o n l y t h e
controlling interests share of goodwill (proportionate
share method). Where companies elect to apply the
Q12. Under the new standard, how shouldnon-controlling interests be measured
at the date of obtaining control?
Will it still be possible to adjust goodwill
after the date at which control is obtained?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
33/88
"Pocket Guide"Pocket Guidel31 l
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
full goodwill method the non-controlling interest is
recorded at fair value as a component of equity.
Companies may also elect to measure non-controlling
interests at the fair value of net identifiable assets (as
per current practice) on a transaction-by-transaction
basis (see Q16).
The goodwill recognised is not adjusted subsequent to
the acquisition date whichever method is chosen to
value non-controlling interests at the acquisition date.
Any subsequent purchase of the non-controllinginterest is reported solely in equity first eliminating the
non-controlling interest and then reducing the equity
of the controlling interest. Current practice is to let
companies choose between adjusting the previously-
re c o g ni s e d g o o d wi l l ( t he no rm ) o r re c o rd i ng a
reduction of equity.
Fair value adjustments applied to identifiable assets
and liabilities (and, therefore, recognised separately
from goodwill) must be recorded within a period of12 months from the date control is obtained. After this
period, any adjustments must be recognised in the
income statement. The scope of this guidance, already
included in the current version of IFRS 3, has been
extended to a larger number of assets and liabilities.
N ew i nt ang ib le a ss et s w il l b e re co gn ise dseparately from goodwill and measured at fair
valueas the reliable measurement criterion is deemed
to be met for all intangible assets. This contrasts with
Q13. When control is obtained, which additional
items acquired must be measured
at fair value?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
34/88l32 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
current guidance that allows buyers to consider that
t h e c o n d i t i o n i s n o t m e t i n s o m e c a s e s . M o r e
intangible assets might be recognised separately
under the new standard instead of being included ingoodwill.
Deferred tax assets will continue to be measured
based on the perceived probability of recovery, but
any subsequent increase in the recoverable amount
must be treated in the same manner as fair value
adjustments to other assets.If the recovery of a deferred tax asset is assessed as
p ro ba bl e m ore t ha n t we lv e m on th s a ft er t he
acquisition date, the recoverable amount is recognised
i n t a x e x p e n s e . T h i s i s a c h a n g e f r o m c u r r e n t
guidance.
Buyers are required to reassess all contracts andarrangements based on the facts at the acquisition
date except for the classification of leases and
insurance contracts. Specifically, they must:
classify items in different categories of financial
assets and liabilities based on their intended use;
re-designate hedge relationships; and
re-examine all embedded derivatives.
The facts at the acquisition date are likely to differ
from those at the time of contract issuance, an
assessment may be reached that is different from that
made by the acquiree (separation or otherwise of the
embedded derivative). Current guidance allows buyers
to choose between conducting reassessments andretaining the accounting treatment applied by the
acquiree.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
35/88
"Pocket Guide"Pocket Guidel33 l
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
Effects on the income statement
in the year of the acquisition
The changes in IFRS 3R may have the following
effects on the income statement in the year of
acquisition:
a reduction in earnings from expensing transactioncosts (these are typically substantial); and
an increase in earnings in the event of a step
acquisition, resulting from the re-measurement to
fair value of the previously-held interest and the
recognition of the resulting gain in the income
statement.
Effects on the income statement
in the years following the year of acquisition
The changes in IFRS 3R may have the following
effects on the income statement in the years following
the year of acquisition:
a reduction or increase in earnings depending onthe nature of re-measurements concerning earn-out
clauses. The volatility of earnings in subsequent
years will be driven by the buyers ability to assess,
at the acquisition date, the probabil ity of the
achievement of the pre-defined performance
objectives on which additional payment is based.
An accurate estimate will reduce subsequentchanges and volatility;
an increase in earnings if the assessment of the
acquirees deferred tax assets at the acquisition
date proves to have been too conservative;
Q14. How does the new IFRS 3 add
to earnings volatility in the year of acquisition
but also in subsequent years?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
36/88l34 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
a reduction in earnings resulting from the recording
of additional amortisation charges related to the
larger number of intangible assets recognised;
a re du ct io n i n e ar ni ng s re su lt in g f ro m t herecognition of impairment losses under the full
g oo dw il l m et ho d ( wh ere a pp li ca bl e) . T he
recognition of goodwill on non-controlling interests
will increase any impairment charges recorded in
subsequent years; and
an increase in earnings in the event of a partialdisposal of a subsidiary with loss of control. A
holding gain (unrealised) is recognised in the
income statement on interest retained as well as on
the interest that has been sold.
An increase in equity in the year of acquisition
if the acquirer chooses the full goodwill method
An acquirer may choose the full goodwill method,
and goodwill attributable to controlling and non-
controlling interest is recognised. The non-controlling
interest is measured at fair value, resulting in anincrease in equity and goodwill. This additional
goodwill is not adjusted if the non-controlling interest
is subsequently acquired by the controlling interest.
Effects on equity on purchase or disposal
of non-controlling interests
The changes contained in IFRS 3R will have thefollowing effects on equity in the years following the
year of acquisition:
a reduction in equity on purchase of the non-
controlling interests. The difference between the
Q15. How does the new IFRS 3
add to equity volatility?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
37/88
"Pocket Guide"Pocket Guidel35 l
acquisition price of the shares in question and the
equity attributable to the non-controlling interest
reduces controlling interest (parent) equity. The
a pp li ca ti on o f t he f ul l g oo dw il l w il l h av e acushioning effect on controlling interest (parent)
equity (see Q16 to Q19);
an increase or reduction in equity in the event of the
disposal of a non-controlling interest (i.e. the
acceptance of shareholders in a subsidiary) with a
gain or loss on disposal. The difference between the
value of the shares and the share of book value of
net assets attributable to the new non-controlling
interest is reported in controlling interest equity.
In conclusion, t h e n e w s t a n d a r d s w i l l h a v e a
significant impact in the year of acquisition and in
subsequent years. Buyers are encouraged to modelthe accounting consequences of different acquisition
strategies and contract terms to avoid surprises (see
Q20 to Q24).
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Fair value measurement and volatility
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
38/88l36 l New IFRS for Acquisitions (M&A)
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
Full or partial goodwill method
How to choose between partial goodwill
and full goodwill under the option availablein the new standard?
Today, in a less than 100% acquisition, a buyer
recognises 100% of the identifiable assets and
liabilities acquired and goodwill calculated a residual
comparing the consideration paid to the acquirers
interest in identifiable assets and liabilities. IFRS 3Rintroduces an option for the buyer to value the non-
controlling (minority) interest at either the minoritys
proportionate share of the net identifiable assets
(residual method as today or partial goodwill) or to
value the non-controlling interest at fair value, thus
recognising goodwill on the non-controlling share (full
goodwill).What would influence an acquirer to choose between the
partial goodwill method and the full goodwill method?
The recognition of full goodwill increases equity at the
acquisition date. It would also reduce any potential
decrease in controlling (parent) equity resulting from a
subsequent buyout of the non-controlling interest. Fullgoodwill might be best suited to companies with a
weak equity base and/or a high level of gearing.
However, the full goodwill method also has a number
of drawbacks:
The fair value measurement of the non-controlling
interest may require the use of complex valuation
techniques; Any subsequent impairment charge is higher than
under the partial goodwill method, with a negative
impact on reported operating results.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
39/88
Buyers are allowed to decide which method is more
appropriate on a transaction-by-transaction basis an
area of flexibility allowed by the new standard.
Companies may choose between two methods for the
measurement of goodwill under IFRS 3R:
The existing partial goodwill method , w i t h
goodwill representing the difference between the
consideration paid and the buyers share of the fair
value of the identifiable net assets acquired.
G o o d w i l l i s s a i d t o b e p a r t i a l b e c a u s e i t i s
calculated solely by reference to the buyers
acquired interest and does not include any goodwill
related to the non-controlling interest. The new full goodwill option, which involves the
recognition of goodwill on both the controlling
interest and the non-controlling interest, with a
corresponding increase in equity attributable to the
non-controlling interest. Thus, when less than 100%
of a company is purchased, goodwill is given the
same treatment as the other assets and liabilitiesacquired: the buyer recognises 100% of goodwill,
i.e. the goodwill that may be said to relate to the
majority shareholder as well as that portion that
relates to the shares held by the non-controlling
interest. The non-controlling interest is measured at
fair value for this purpose.
The impact of the full goodwill method is different from
that of the partial goodwill method only if less than
100% of a company is acquired. The option offered by
Q16. What is the choice under the new standard
with regard to the treatment of goodwill?
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
l37 l"Pocket Guide"Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
40/88
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
41/88
charged against controlling interest equity. The
application of the full goodwill method:
lessens the impact of the buyout of non-controlling
interest, provided that the fair value of the non-controlling interest has remained stable between the
acquisition date and the buyout date; and
limits the decrease in controlling interest equity
when the fair value of the non-controlling interest
has increased between the acquisition date and the
buyout date.Us e o f t he ful l g o o d wi l l m e t ho d c a n b e s a i d t o
strengthen equity at the acquisition date and cushion
controlling interest equity in the context of subsequent
non-controlling interest buyouts. This may offer
advantages when the acquisition of an initial 51%
controlling interest is to be followed by significant non-
controlling interest buyouts.
Partial goodwill in an less than 100% acquisition is
calculated as the difference between the consideration
paid and the acquirers interest in the fair value of theacquirees identifiable assets and liabilities. The non-
controlling interest is measured at its proportionate
share of the net identifiable assets.
However, the non-control l ing interest must be
measured at fair value at the acquisition date under
the full goodwill method. Buyers are expected, inpractice, to determine this fair value based on the
m a r k e t v a l u e o f t h e s h a r e s n o t o w n e d a t t h e
acquisit ion date. However, in the absence of a
reference market value, it may not always be possible
Q18. Why does the full goodwill method entail the
use of more complex valuation techniques?
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
l39 l"Pocket Guide"Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
42/88
to extrapolate the price per share paid by the buyer to
acquire a controlling interest in order to measure the
non-controlling interest. The consideration paid might
have included a control premium, for example.Valuation experts may be necessary to assess the
existence and amount of any premium. Alternative
valuation techniques may be required (market-based
data, similar transactions or models based on future
earnings or cash flows) if a straightforward approach is
not appropriate.
Application of the partial goodwill method, when less
than 100% of a company is acquired, results in any
goodwill impairment charge being allocated solely tothe controlling interest.
Any impairment charge under the full goodwill method
is based on 100% of goodwill and, therefore, is higher
than that resulting from the partial goodwill method.
Impairments should not occur more frequently under
full goodwill because of the impairment testingrequirements for partial goodwill, but they may be
larger. Full goodwill also results in a requirement to
a ll oc at e t he i mp ai rm en t c ha rg e b et we en t he
controlling and non-controlling interests. This can be a
complex process depending on the level at which a
company tests goodwill and how it groups its CGUs.
Therefore, the increase in equity upon the acquisition
of a controlling interest under the full goodwill method
could be followed by a negative earnings impact in
subsequent years if an impairment occurs.
Q19. Why does the application of the full goodwill
method result in a higher charge in the event
of impairment?
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
l40 l New IFRS for Acquisitions (M&A)
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
43/88
The choice of full goodwill method might prove
unfavourable for cyclical industries or where there is a
r is k t ha t i n it ia ll y i de nt if i ed s yn erg ie s w i ll n ot
materialise.
However, with non-controlling interests as part of
equity, related impairment losses will be apportioned
between profit/loss attributable to the group and
profit/loss attributable to non-controlling interests at
the foot of the income statement. Thus, any increase
in the impairment charge would have a neutral impacto n e a rni ng s p e r s ha re a s c a l c ul a t e d b a s e d o n
profit/loss attributable to the group.
Impairment testing under the full goodwill method may
be less complex than under the partial goodwill
method although this will differ from company to
c o m p a n y . T h i s i s b e c a u s e f o r t h e p u r p o s e o f
impairment testing, partial goodwill must be increasedby the amount of goodwill allocated to the non-
controlling interest in order to derive the carrying
amount of the cash-generating unit (CGU) or group of
cash-generating units and to compare it with the
ascribed value in use or market value. Any impairment
loss is then reduced by the amount related to the non-
controlling interest. Such restatements are eliminated
during impairment testing under the full goodwill
method. However, the application of the full goodwill
method means that the impairment must be allocated
between the controlling and non-controlling interests.
This allocation can be a complex process.
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
l41 l"Pocket Guide"Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
44/88
In conclusion, the full goodwill option may be more
favourable in practice from an equity perspective
notwithstanding the possibility of higher impairment
charges. Entit ies might consider use of the fullgoodwill method particularly in the following cases:
sizeable acquisitions;
acquisitions to be followed by significant non-
controlling interest buyouts; and
companies with a weak equity base and/or a high
level of gearing.
IMPACTS ON FINANCIAL STATEMENTS AND COMMUNICATION
Full or partial goodwill method
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
45/88
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
46/88
Adaptation of acquisition strategies
Why should decision-makers anticipate
the new version of IFRS 3 and adapt acquisitionand disposal strategies and terms accordingly?
Acquisition and disposal decisions should not be
driven by accounting considerations. Moreover, the
exact time frame for deal-making and negotiations is
seldom known in advance. However, decision makers
like to be able to develop their own strategy, be that: purchasing an equity stake in the target company
prior to pursuing control, in order to test the water;
purchasing a minimum controlling interest at first
and buying out NCIs (NCI, previously minority
interest) at a later date;
acquiring 100% control from the outset, increasing
t he v a l ue o f t he a c q ui re d b us i ne s s a nd t he ndisposing of shares without, however, giving up
control; or
acquiring control, increasing the value of the
acquired business, then disposing of shares and
retaining only a NCI.
The terms of transactions under IFRS 3R could have
very different and potentially counter-intuitive effects
on earnings and equity. Management should consider
if the previous strategy for business acquisitions is the
right one under the new accounting requirements. The
best way to avoid surprises is to anticipate the
consequences of the proposed transaction terms and
t h e n e w a c c o u n t i n g s t a n d a r d o n t h e f i n a n c i a lstatements at an early stage and to model potential
outcomes.
This chapter considers the impact of IFRS 3R on
common transaction structures.
l44 l New IFRS for Acquisitions (M&A)
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
47/88
"Pocket Guide"Pocket Guide"Pocket Guide"Pocket Guidel45 l
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
Successive share purchases (with the buyers interest
increased from, say, 30% to 60%) under the current
standard result in the previously-held equity interest in
the acquiree (30% in our example) re-measured to fairvalue and the resulting gain recognised in equity.
The gain will be recognised in the income statement
under IFRS 3R. This will have a positive impact on
earnings in the year of acquisition, losses are also
theoretically possible but are not expected to occur in
practice.
If the buyer has a choice, does the accounting look
more attractive for a successive share purchases (step
acquisition) or to acquire a controlling interest at a
stroke?
A step acquisition will entail the recognition of a gain
in the income statement, corresponding to the
unrealised gain on the previously-held equity interest.
Yet, there will be no cash inflow for the buyer. In
contrast, where control is achieved in a single stage,
no gain will be recognised in the income statement.
Instead, the increased value of the acquired business
is reflected in goodwill, but there will also be an
outflow of cash.
Q20. You are used to taking control in steps
In future, why will there be a positive impact
on earnings at the date at which controlis obtained?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
48/88
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
l46 l Acquisitions, Cessions et Joint-ventures
Another common approach is the acquisition of a
minimum controlling interest (51%) and subsequent
purchase of the NCI: under the new standard, eachpurchase of a further interest past control will reduce
the equity of both the controlling and NCIs.
Current practice in a buyout of a NCI is to record the
difference between the acquisition price and the book
value of the NCI either in goodwill or as a charge
against equity. The additional goodwill approach is
most widely used in practice although a handful oflarge IFRS preparers apply a form of economic entity
that results in the excess of the consideration paid
over book value of the NCI is a reduction of controlling
interest equity.
The new guidance requires the adoption of the
economic entity model and the difference, above theNCI, is a reduction of controlling interest equity. Equity
is reduced by the acquisition of a NCI.
This impact may be mitigated by the application of the
full goodwill method for the business combination
accounting on day 1. Goodwill, under this method, is
recognised on both the controlling interest and the NCI.
This results in a gross up in goodwill and a corres-
ponding increase in equity for the NCI. The decrease in
equity resulting from a NCI buyout is offset by the
higher value of the NCI at the date of obtaining control
Q21. You are used to acquiring a minimum
controlling interest (51%) and subsequently
buying out the non-controlling interestIn future, why will each buyout transaction
have a negative impact on equity
for the year in question?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
49/88
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
as included in full goodwill and equity. The applica-
tion of the full goodwill method limits the reduction in
controlling interest equity on the buyout of a NCI to the
amount by which the fair value of the purchased shareshas increased between the date of obtaining control
and the buyout date. The full goodwill method
cushions the impact on controlling interest equity.
The news is not all good, though. The full goodwill
method increases the amount of any impairment
charges that are included in the operating result (SeeQ19).
It is also common for a business to acquire 100% of
another, increase the value of the acquired business
and then dispose of an interest without losing control.
Under the new standard, no disposal gain is recognised
in the income statement on this transaction.Current practice sees two main approaches to
account for disposal of an NCI: the difference between
the disposal price of the shares and the carrying
amount of the corresponding NCI is reported either in
equity or in the income statement. Most companies
recognise the gains in the income statement.
IFRS 3R requires the recognition of gains on partial
disposals of shares in a subsidiary without loss of
control in equity and prohibits recognition in the
income statement.
Q22. You are used to acquiring 100% control
from the outset, increasing the value
of the acquired business and then partially
disposing of shares without losing control
In future, why will the related disposal gainnever impact the income statement?
l47 l"Pocket Guide"Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
50/88l48 l New IFRS for Acquisitions (M&A)
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
In future, why will there be a positive impact on
earnings in the year of disposal?
A gain on disposal, under present standards, is
recognised in the income statement and:
if the equity method is applied to the retained
shares, the interest is stated at the consolidated
carrying amount at the disposal date; or
if the retained shares are treated as available-for-
sale (AFS) financial assets, they are re-measured to
fair value, with a corresponding impact on equity.
Accordingly, no gain is recognised on the retained
interest in either case.
The requirement to recognise a gain or loss on the
shares disposed of in the income statement when
control is lost stays under IFRS 3R. However, theretained interest must be re-measured to fair value and
any related gain or loss is also recognised in the
income statement. This treatment is applicable
irrespective of whether the retained shares are
subsequently accounted for under the equity method
or as a financial asset.
Accordingly, disposals resulting in a loss of control
increase earnings by the amount of the unrealised gain
on the retained interest as if the interest in question
has, indeed, been sold.
Q23. You are used to acquiring control,increasing value of the acquired business
and then reducing the equity investment
to a non-controlling interest
In future, why will there be a positive impact
on earnings in the year of disposal?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
51/88
"Pocket Guide"Pocket Guidel49 l
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
The different scenarios il lustrate the potentially
powerful accounting impact of the prescribed changes
under the new standard. The information should
provide some insight for companies into possible
changes to their transaction strategy. Any company
considering a transaction would be well advised toconsider some of the specific aspects of the standard
as described in this section.
M od el li ng d if fe re nt o ut co me s o f p ro po se d
acquisitions and disposals will give insights into
the impact on earnings and equity of planned
acquisitions and disposals
The effects of the new guidance should be considered
in the light of the state of the companys financial
position (for example, a thin equity base), planned
growth and restructuring strategies, and essential
financial communication content (impact on financial
position and performance ratios).
This analysis should not be confined to the impact inthe transaction year alone. Projections should also be
made for subsequent years, notably in respect of any
increase in the volatility of earnings and equity (see
Q11 to Q15).
Companies should look at their available valuation
resources and the increased demands under thenew standards and fill any gaps
T he m o d e l l i ng d e s c ri b e d a b o ut , t o g e t he r wi t h
transaction accounting requirements, will expand the
Q24. How best way to anticipate the accounting
consequences of the new guidance and
realigning acquisition/disposal strategies?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
52/88l50 l New IFRS for Acquisitions (M&A)
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of acquisition strategies
need for valuation expertise. This will embrace, for
example, the revaluation of assets and liabilities
owned prior to the acquisition of control, the re-
measurement to fair value of NCIs (which may notnecessarily be correlated to the price paid to acquire
control) and the re-measurement to fair value of a NCI
retained following the loss of control.
Management might look to pull forward or
postpone transactions planned for 2008 and 2009
If a company has full control over the timing ofacquisitions and disposals planned for 2008 or 2009, it
should compare the related accounting consequences
under the current standard with those under IFRS 3R.
If the current standard is deemed to have more
favourable consequences, transactions could be
carried out prior to the compulsory application ofthe new IFRS 3, i.e. before 2010 in the case of
companies with a 31 December financial year-end.
Conversely, if the new guidance is deemed to be
more favourable and if circumstances permit,
t ra ns ac ti on s c ou ld b e p os tp on ed u nt il t he
application date of the new standard.
An alternative to altering the time frame for deals
could be early adoption of the new standard
Early adoption is not available to European companies
until the standard has been endorsed by the European
Union but could be early adopted by others.
In conclusion, the impact of IFRS 3R on future
acquisitions and disposals need to be anticipated
now.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
53/88
"Pocket Guide"Pocket Guidel51 l
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
Adaptation of contractual clauses
IFRS 3R - how might it change contracts for business
combinations?
Managers are already taking a close look at the
contractual clauses associated with acquisitions,
particularly with regard to the cash component of
earn-outs, post-acquisition payments to selling
shareholders and indemnity clauses. Depending on
the terms of the arrangement, fair value adjustmentsrelated to these items might need to be recognised in
the income statement, rather against goodwill as
today. Good planning and hard negotiating may
reduce or eliminate earnings volatility in the wake of an
acquisition. There are some significant areas that merit
consideration to meet this challenge:
expand the scope and extent of due diligence workand either replace earn-out arrangements by a
d ef in it iv e a cq ui si ti on p ri ce ( l oc ke d b ox
mechanism) or shorten the duration of earn-outs;
p ay e ar n- ou ts i n a f ix ed n umb er o f eq ui ty
instruments;
use valuation experts and benchmarking techniques
to assess the fair value of earn-out clauses as
accurately as possible.
However, to reduce or eliminate earnings volatility,
companies should:
negotiate for robust liability indemnification clauses
and better monitor related compliance; and
carefully word clauses governing payments due toformer owners retained in the business after the
acquisition date.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
54/88
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
55/88
"Pocket Guide"Pocket Guidel53 l
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
shares to the seller, regardless of the fair value of the
shares, is an equity instrument and no subsequent re-
measurement through the income statement is
required.
Earn-out clauses are typically paid in cash or in a
variable amount of shares. Re-measurements of earn-
outs to fair value through the income statement, underIFRS 3R, may lead to earnings volatility in the years
following the acquisition.
B uy er s m ig ht c on si de r t h e f ol lo wi n g ( l im it ed )
opportunities when formulating transaction provisions.
Extending due diligence work, eliminating earn out
clauses by achieving an accurate valuationof the acquiree at the acquisition date
or shortening the duration of the earn-outs
Elimination of earn-out clauses and contingent
consideration is the best way to reduce volatility,
however it significantly limits flexibility in transaction
structures. This approach would also eliminate theabil i ty to adjust the cash consideration for the
transaction. The scope and extent of pre-transaction
due di l igence work would therefore have to be
expanded substantial ly to achieve an accurate
valuation of the acquiree at the acquisition date. This
solution would be most suited to companies operating
in very mature markets. However, it would not beappropriate, for example, for start-ups operating in
fast-growing markets.
Q26. How may earn-out clauses be amended
to reduce post-acquisition earnings volatility?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
56/88
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
57/88
"Pocket Guide"Pocket Guidel55 l
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
I n d e m n i t i e s a r e u s u a l l y g r a n t e d i n r e l a t i o n t o
environmental risks, ongoing lawsuits, customer
warranty liabilities, tax risks and so forth.
Such contingent liabilities, under current guidance, are
recorded as liabilities in the acquisition balance sheet.Subsequent adjustments after the 12-month time limit
for finalising the business combination accounting are
charged to the income statement.
With the new standard, the sellers commitment to
discharge (provide refunds for) these contingent
liabilities is recorded as an asset of the buyer. Theasset is measured based on the contractual provisions
and is limited to the amount of the indemnified item.
Any reassessments after the acquisition date are
reflected in both assets and liabilities, with no net
impact on the income statement i f the buyer is
indemnified for the whole amount of the risk.
Buyers may also wish to negotiate extended liabilityindemnification. However, the new accounting
t re at me nt re qu ire s t he i nc lu si on o f a f or ma l
reimbursement clause for each type of guarantee
provided. The indemnity payable by the seller is
measured using the same assumptions applied to the
related contingent liability.
Unless each risk covered is precisely identified, the
liability indemnification clause is likely to generate
a c c o unt i ng m i s m a t c he s , a s und e r t he c urre nt
standard.
Q27. Why will the new IFRS 3 prompt
the extension of the protection provided
under liability indemnification clausesand better monitoring of related compliance ?
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
58/88
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
A contingent payment made to a former owner
retained in the business after the acquisition may be
construed as compensation for future services and,
therefore expensed in post-acquisition earnings.
Former owners often continue to work in the companyafter the completion of the acquisit ion as their
professional skills and relationships can contribute to
the future success of the acquired business.
Payments made by the buyer to the former owners in
t he i r c a p a c i t y a s t he s e l l i ng s ha re ho l d e rs a re
considered to be part of the consideration paid for the
shares and, therefore, are included in goodwill.Payments made by the buyer to the former owners in
their capacity as retained employees providing
services are expensed as incurred. The latter type of
payments serve to lock in the former owners and
reward them for future services, rather than as
consideration for the acquired business.
Previously, no explicit guidance was provided to
indicate whether such payments to former owner-
man ager s were to be treated as part of the
consideration paid for the business or as
compensation for future services.
Q28. How do the new refined requirements
increase the ride of mandatory expensing
of contingent payments to former ownersretained in the business?
l56 l New IFRS for Acquisitions (M&A)
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
59/88
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
I F RS 3R fo l l o ws t he e xa m p l e o f US G AAP a nd
provides a list of criteria to consider when determining
the appropriate accounting treatment. Buyers will have
t o s c rut i ni s e t he p ro p o s e d wo rd i ng o f c l a us e s
governing contingent payments to former ownersretained in the business with a view to substantiating
the classification of such payments in goodwill and
avoiding expensing them in the income statement in
subsequent years.
For example, as a general rule, payment to a former
owner-manager should be treated as compensation
and expensed, when it is stipulated that:
the contingent payment is forfeit if the individual
leaves the company; or
the contingent payment is granted only to selling
s hareho ld e rs who rem a in i n t he c o mp a ny s
employment and not to other selling shareholders.
However, this is not the sole accounting issue to beconsidered when formulating contingent payment
cl au se s. Th e c la ss if ic at io n of a p aym en t a s
compensation for services rather than as part of the
p urc ha s e c o ns i d e ra t i o n a l s o p o s e s t he r i s k o f
reclassification under company and tax law. This
would concern not only the buyer, but also the
employee as it may have consequences for social
security, employment charges and income tax.
Q29. Which precautions should be taken to ensure
that contingent payments to former owners
retained in the business qualify for inclusionin goodwill, as opposed to being expensed?
l57 l"Pocket Guide"Pocket Guide
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
60/88l58 l New IFRS for Acquisitions (M&A)
In conclusion, it is possible to limit volatility in the
income statement following an acquisition, provided
that the contractual clauses have been revisited on a
timely basis.
Once the acquisition agreement is signed, however,
there will be no going back.
STRATEGIC AND OPERATIONAL IMPACTS
Adaptation of contractual clauses
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
61/88
"Pocket Guide"Pocket Guidel59 l
STRATEGIC AND OPERATIONAL IMPACTS
Use of expert valuations
Use of expert valuations
How does IFRS 3R increase the use of valuations
in acquisitions and disposals?
Accurate fair value measurements of acquired assets
and liabilities in a business combination can present
real challenges to companies today. The wider use of
fair value under IFRS 3R may increase both the
number and complexity of valuations.
There is an incentive for assessments to be even moreprecise and reliable, given that re-measurements after
the acquisition date will be recognised in the income
statement.
The main consequences on the valuation front are
likely to relate to:
estimates of earn-outs, including the modelling oft he p ro b ab i li t y o f p re -de fine d p e rfo rma nce
objectives being achieved;
the analysis and quantification of control premiums,
with a view to measuring non-controlling interests;
the measurement of unusual intangible assets or
i n de mn it ie s c on ce r ni n g l i ab il i ti es , s uc h a s
environmental risks; and the reassessment of financial assets and liabilities,
notably hedging instruments and embedded
derivatives.
8/13/2019 Pwc Pg News Ifrs Piecemeal Acq
62/88l60 l New IFRS for Acquisitions (M&A)
STRATEGIC AND OPERATIONAL IMPACTS
Use of expert valuations
As specified in Q11, the new IFRS 3 requires that
earn-out clauses be measured at fair value at the date
at which control is obtained, with probability of
payment built into the measurement of the liability. If
the earn-out is paid in cash or in a v